Pitfalls of accounting treatment: Many companies use structured wholesale energy market contracts for the procurement of electricity and natural gas rather than full supply contracts.
Many companies now use structured wholesale energy market contracts for the procurement of electricity and natural gas rather than full supply contracts. The wide range of contractual arrangements offered in the energy sector has increased significantly in recent years. These frequently offer the option of flexible price arrangements. This also allows SMEs to hedge their energy procurement costs at an early stage and to take into account price expectations in a manner that previously was only possible with the use of listed trading products. However, it is also important in this context to ensure that such contracts are recognised correctly in the financial statements.
Many wholesale energy market contracts, also in the case of physical supply of the underlyings, fulfil the requirements of a derivative pursuant to IAS 39.9 (value changes in response to the change in an underlying, no/low initial net investment, and settled at a future date). Therefore, they must always be measured at fair value. This requires regular fair value measurement and recognition, and results in corresponding fluctuations in profit or loss if hedge accounting is not applied. The same applies to other material procurement contracts as well as related sales contracts (e.g. metals, soft commodities). Therefore, this issue usually concerns companies with high energy requirements and those involved in the procurement and sale of commodities.
Classification as a derivative and thus recognition at fair value can – in exceptional cases defined by the standard – be avoided and the procurement contract nevertheless be treated as an unrecognised firm commitment, if certain conditions are fulfilled. Application of the so-called 'own use exemption' requires that the contract was entered into to cover operational energy requirements. Breach of these requirements may result in 'tainting' of the contract and all similar contracts and require immediate application of IAS 39.
In practice, when applying the own use exemption, it must be ensured that all contracted quantities are actually physically supplied and no financial settlement occurs prior to or at maturity. In line with direct cash settlement, offsetting transactions with third parties to close a position as well as short-term sale upon receipt of the goods are treated as adding no further value to the contract. This means in the case of wholesale energy market contracts that opening or closing previously price-fixed quantities to compensate for changes in fair market value is not permissible, even if this would be advisable from an economic perspective. Only in a few exceptional cases explicitly specified in the standard, such as rare and unforeseeable events, is a contract not considered tainted due to an exceptional event.
We recommend the following procedures to ensure the proper accounting treatment of contracts for the procurement and sale of goods:
The own use exemption rules remain largely unchanged under IFRS 9, so that extensive amendment will not become necessary.
Source: KPMG Corporate Treasury News, Edition 61, November 2016
Author: Daniel Rahmann, Manager, Finance Advisory, firstname.lastname@example.org
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